The importance of focusing on the cost of fuel products, and not crude oil
Refineries are currently earning a lot of money with margins hitting record levels both in the U.S. and Europe.
By Ole Hansen, Head of Commodity Strategy at Saxo Bank
Crude oil continues to trade rangebound within a narrowing range, in Brent currently between $98 and $110 per barrel. It did, however, not prevent the cost of fuel products from surging higher last week. Diesel, the workhorse of the global economy, rallied strongly led by tightening supply in the New York area driving prices to historic highs. The war in Ukraine, and subsequent sanctions against Russia, have upended global supply chains while at the same causing a significant amount of stress in the physical market, especially in Europe where Russia for years has been the most important supplier of fuel products.
To fill the void and to benefit from soaring prices, U.S. Gulf Coast refiners have been sending more cargoes to Europe and Latin America at the expense of the U.S. East Coast where stockpiles consequently have dropped to the lowest since 1996. With New York harbor serving as the delivery point for futures trading in the NY Harbor Ultra-Light Sulphur Diesel contract, the tightness there is having an outsized impact on visible prices.
These developments highlight the importance of focusing on the cost of fuel products, and not crude oil, when trying to determine the price levels where demand starts to be negatively impacted by higher prices. As a result, refineries are currently earning a lot of money with margins hitting record levels both in the U.S. and Europe. The charts below show the crack spreads, or the margin achieved by producing diesel from WTI in the U.S. and Brent in Europe.
With the war ongoing and the risk of additional sanctions or actions by Russia, the downside risk to crude oil remains, in our view, limited. In our recently published Quarterly Outlook, we highlighted the reasons why oil may trade within a $90 to $120 range this quarter and why structural issues, most importantly the continued level of underinvestment, will continue to support prices over the coming years.
With regards to the lack of investment currently creating concerns about future level of supply, we will be keeping a close eye on earnings this week from European oil majors such as Shell, Enel, BP and Equinor. Also, given the mentioned surge in refinery margins, the result from Valero.
